What if Everything you Know about Money is Wrong?

One problem with reading financial blogs is that you seem to get a lot of the same advice, over and over again. Most of this advice is time tested and well meaning. It comes from smart people and is based on sound principles. But, it may not work for you. What if all of this financial advice is wrong? What if the conditions are changing and the old rules no longer apply?

Can you afford to bet your financial future on advice that is outdated?

Investors are Overconfident

Image by Alex E. Proimos

I have been investing for a long time and I have seen and made plenty of mistakes. The biggest mistake is thinking what worked well in the past will work in the future. It’s called the Normalcy Bias and it has fooled a lot of experienced investors.

For years, financial planners have used projections of 2-3% inflation and a 7-8% investment return. There was a time when those numbers were realistic. In the future, they may not be. I believe inflation is closer to 7% right now and it may rise. Index funds have returned very little in the past 10 years and that may continue in the future. We may face another decade like the 70s where the stock market is flat and inflation is high.

Investors aren’t expecting a decade of high inflation or low returns.

Economists are Deceptive

Another problem is that we are constantly being reassured that everything is OK with the economy, when it’s obvious that it isn’t. Our elected officials care more about their political parties and reelection then the strength of our nation. The banks care more about fleecing their customers and gambling with derivatives than protecting the global economy. Not only are they distracted from their mission, they are grossly negligent in their duties. Ordinary citizens like you and I will have to pay the price for their failure.

The reality is that inflation is close to 7%, when calculated using the 1990 CPI standard. The unemployment rate is around 23%, when using the 1994 standard, which included short and long-term discouraged workers. The U3 rate reported by the BLS only includes the 9% of people receiving benefits. This makes it difficult to judge the economy and plan for the future. The only thing you can count on is the bias will continue, because the government can’t afford to publish the accurate rates of inflation and unemployment.

The Deficit is Unsustainable

Everyone knows the federal deficit is out of control. In fact, it has almost doubled in the five years I have been writing this blog. While the Budget Super Committee is arguing back and forth about how to cut $1.2 Trillion in the next 10 years, the deficit is growing at $1.3 Trillion per year. So far, we haven’t suffered any dire consequences from this reckless spending. But, that day is certainly coming soon and likely sooner than most people expect.

I don’t have a PHD in Economics, but I’m pretty good in math. And simple math tells me there is no possible way for the government to repay the deficit. Even if they cut Federal spending in half tomorrow, it would take over 30 years to pay off the deficit. That’s at the artificially low interest rates we have today. If the interest rates were to suddenly shoot up near the real rate of inflation, the annual interest on U.S. debt would surpass $1 Trillion and eat up close to half of the Federal revenue. If you add in the unfunded liabilities from public pensions, Medicare and Social Security, the budget numbers are hopeless.

There is no possible way for the U.S. Federal government to pay off its debts.

The Dollar is Declining

So far, the Feds have gotten away with overspending using two dirty little tricks. First, they force exporting nations, like China, to balance the current account by accepting our debt. Second, they simply print more money. Both of these scams have consequences. The Chinese and other nations are growing weary of our debt. They have been quietly meeting with other countries to find a way to trade around the dollar. We have recently lost our AAA credit rating and further downgrades could cause investors to dump our Treasury bonds. We have been printing money like crazy and the inflationary effects are already starting to appear. The U.S. dollar has fallen nearly 30% since 2002.

Inflation could easily reach double-digits, like it did in 1947 and 1980.

The Government is Desperate

Where will all of this lead us? Will the Treasury Department try to inflate their way out of debt? Will they devalue the dollar or raise taxes dramatically? Will they try to nationalize industries or confiscate private assets? I know this sounds unrealistic, but there are many historical precedents. Most American’s probably don’t know the U.S. confiscated all the gold coins and bullion in 1933 and it was illegal to own gold, except as jewelry, until 1974. People may not realize the British Pound was devalued by 30% before it lost status as the world’s reserve currency. Most people have no idea how much exposure the U.S. financial system has to shaky European debt.

Unless we change course, it’s not unthinkable the U.S. could:

Lose Status as the World’s Reserve Currency

Trigger Hyper Inflation

Devalue our Currency

Default on Bonds and Debt Obligations

In a crisis, citizen’s rights will be trampled and private assets coveted.

Surviving the Apocalypse

OK, that’s enough doom and gloom for one post. There are a number of ways to protect your wealth and reduce your exposure to inflation and currency devaluation. The most important thing is to diversify from a portfolio of purely financial investments, such as stocks, bonds, CDs and mutual funds. It is also important to diversify from a portfolio that is exclusively denominated in U.S. dollars. Real assets tend to hold their value in times of high inflation and it will be important to own a much higher percentage if the dollar hits the fan.

Investments that could buffer inflation and currency problems:

Real Estate

Commodities

Foreign Assets

Precious Metals

It’s impossible to own the dollars without being exposed to the debt.

The Bottom Line

The bottom line is that it’s no longer practical to stick money in an index fund and expect to prosper. Anyone who isn’t diversifying both their income and their investments may be risking a difficult future.

23 comments to What if Everything you Know about Money is Wrong?

No definitely not. I started saving with a very low income and was able to raise a family and buy a house. I was also able to increase my income, which sounds like it would help you a a lot.

Make some goals, write them down and then go for it. Even if you fall short of your goals, you will be better off than you are now. It’s amazing how much better you will feel, just by choosing a direction.Bret recently posted..Money Fail: Never Track Finances

I’ve explained to people that our trade deficit with China isn’t worrying (for us) but it is unsustainable. Basically, they send to us manufactured goods, building materials, electronics, and other cool things, we send to them little green pieces of paper (dollars or bonds). At some point they won’t be as enamored with that paper and start to either demand more of it, or send us less cool things.

The other bad thing about inflation is there is no ‘average person’. Sure, you might be a perfectly average guy in an average town who switches the goods you purchase when inflation rises, has no kids, and uses little medicine. However, what about a grandparent who is paying for a grandson’s education? Medicine and education, two ‘bubble contenders’ will take up the highest proportion of the budget. Oh, and it’s growing…

China not only has to trade with us in dollars, but they also have to trade with other countries in dollars for commodities, such as oil. They have pushing for an alternative to the dollar for many years, but other currencies are even worse off. And, their Won is so completely manipulated for cheap exports, that criticizing us is kind of disingenuous.

Although it’s impossible to measure CPI for an average person that will apply to everyone equally, it would help everyone a lot to have a more accurate average.Bret recently posted..Money Fail: Never Track Finances

You’re correct, I think we’re entering a phase of new normal, and backward-looking projections won’t apply as predictably as they have in the past.
It’s not unthinkable that the US Govt could default on the debt, or devalue the currency. The switch from silver coins in 1964 was just such a devaluation.101 Centavos recently posted..Random Reads

Yes, and the new normal doesn’t look so great for investors. I wonder if the markets will come back around or if we will have to suffer for many years. One thing is for certain, our elected officials are way too partisan and incomepetent. If something doesn’t change with the spending soon, they will likely default.

I was born in 1964 and my Dad used to collect all of the silver coins from us. My folks sold most of their silver in 1980, the last time it peaked.Bret recently posted..Money Fail: Lenders of Last Resort

I love the quote at the end. Gave me a real chuckle. I agree with 101. The government can be unpredictable and doesn’t always make the best decision. They have proved that over and over again. We really need to take responsibility for what we can control and do the best we can with that. The rest is out of our hands.

I do agree though that we need to stress the importance of coming up with a sustainable solution. Otherwise we are just going to keep failing and that gets no one anywhere.Miss T @ Prairie Eco-Thrifter recently posted..How Are Billionaires Different Than Millionaires?

It’s bizarre how disfunctional our government is right now. They are spending money and accumulating debt at a frightening rate. Neither side will compromise for a reasonable solution. It’s a recipe for disaster.Bret recently posted..Money Fail: Never Track Finances

Really good points you brought up- what is the solution? I think we all need to take it in our own hands and we probably shouldn’t be looking to our leader for advice because they are giving us mixed messages.

The only solution is to get real and cut spending. Raising taxes won’t balance the budget and neither will cutting the military, although it needs to be cut. The bottom line is that entitlements now consume 65% of the federal budget and this is way up beyond any historic measure. It’s unsustainable and it has to be reformed. Way too many people are taking benefits they don’t need and the honest people have to pay for it.Bret recently posted..Money Fail: Ignoring Unpaid Bills

Okay, this is definitely one interesting perspective. I do think being able to move beyond old advice that no longer works is key. However, the challenge is differentiating between what no longer works versus what just doesn’t work right now.

Additionally, I think part of the reason some people are against increasing tax revenues stems from the long track record of funds not being used appropriately. Simply put, it’s hard to have an unbiased conversation on tax reform or government spending anymore with the competing agendas.Roshawn @ Watson Inc recently posted..Broke People Afford Everything!

The government already brings in way more in taxes than they need to run this country. It has been proven many times that raising taxes just inflates the size of the government and doesn’t decrease the deficit. Right now, a huge amount of money is being redistributed by the government, which isn’t fair to taxpayers.

The best solution I have seen is a constitutional balanced budget ammendment that caps the government’s budget as a percentagee of GDP. That is the fairest and most logical thing, to tell the government up front, “You only get 20% of the country’s GDP and you can’t run a deficit.” Unfortunately, it didn’t pass, but I think it might in the future.

The tax system definitely needs to be overhauled. Only 53% of taxpayers are paying 97% of the taxes. That’s not fair at all. Plus, big companies like GE made $5.5 Billion in the U.S. in 2010 and paid zero taxes. That has to end now.Bret recently posted..Money Fail: Broke on Thursday

I think in these financially fragile times everyone should be doing everything they can to learn about new ways to increase their wealth. Unfortunately, these days it seems everyone is waiting for the government to do something for them. I think people should stop waiting for help and learn to do for self. Just my two cents.Louie recently posted..Dec 21, Beyond Technical Analysis Part II

I think a lot of people who are counting on the government to take care of them are going to have a rude awakening. The government is a lot better at making promises than keeping them. All you have to do is to look at what is happening with pensions and entitlements to know it’s all going to blow up sooner or later.